The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Birlasoft Limited (NSE:BSOFT) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
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What Is Birlasoft's Debt?
You can click the graphic below for the historical numbers, but it shows that Birlasoft had ₹1.23b of debt in March 2022, down from ₹1.28b, one year before. But on the other hand it also has ₹11.6b in cash, leading to a ₹10.4b net cash position.
How Healthy Is Birlasoft's Balance Sheet?
We can see from the most recent balance sheet that Birlasoft had liabilities of ₹6.60b falling due within a year, and liabilities of ₹1.40b due beyond that. Offsetting this, it had ₹11.6b in cash and ₹11.4b in receivables that were due within 12 months. So it actually has ₹15.1b more liquid assets than total liabilities.
This excess liquidity suggests that Birlasoft is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Birlasoft has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Birlasoft grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Birlasoft's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Birlasoft has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Birlasoft produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Birlasoft has net cash of ₹10.4b, as well as more liquid assets than liabilities. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in ₹2.2b. So is Birlasoft's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Birlasoft .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About NSEI:BSOFT
Birlasoft
Provides software development services in India, the Americas, Europe, the United Kingdom, and internationally.
Flawless balance sheet established dividend payer.
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